The IMF held a high-level conference last week on unwinding public interventions in thefinancial sector. Insightful discussions took place among policymakers, academics, and the private sector, highlighting several areas where a broad consensus appears to be emerging, as well as some challenges that policymakers are about to face.

Converging views

There was broad agreement that an exit strategyfrom monetary, fiscal, and financial sector interventionsis essential.The pivotal goal of this exit process would be to arrive at a condition of price stability, fiscal sustainability, and financial stability, including a new financial landscape that is much safer than currently exists. This will provide the necessary underpinnings for stable, strong, and balanced growth.

It will be relatively easy to unwind financial interventions that have sunset clauses or have penal rates so they become unattractive as market conditions normalize (photo: Sajjad Hussain/AFP/Getty Images)

The strategy will need to be clear, credible, consistent, and comprehensive, addressing the multidimensional issues that have ensued from the intervention measures. That said, tailoring the strategy will likely be more an art rather than a science because of the uncertainties and the need to have firm assurances that it will not undermine recovery.

Diverging views

Views differed regarding the timing of the exit process. Some participants argued that it was better to exit earlier because of possible fiscal policy lags and/or potential new asset bubbles. Others argued it was too early to exit given that global economy prospects still remain highly uncertain. On balance, however, the Fund believes that the risk of exiting too early is higher than exiting too late.

There was also no clear consensus regarding the sequencing of an exit strategy.Some felt that fiscal adjustment should take place first to ensure easier exit from monetary policy measures. Others argued this may not be feasible because the political process of unwinding fiscal interventions would likely be long and complicated and hence monetary policy accommodation should be unwound first.

Some principles for exit strategy

Exit strategies need to be consistent at three levels. First, there needs to be consistency between monetary, fiscal, and financial policies in each country. Second, exit plans from different financial sector interventions need to be consistent. Third, individual country policies should be internationally consistent to avoid undesirable spillover effects, including from advanced to emerging market economies.

Further, economic and financial indicators should guide the exit strategy. These indicators should include quantity, as well as price signals—in particular, developments in the aggregate and sectoral credit variables.

Main challenges ahead

There are many challenges that lie ahead. The most difficult will be the fiscal exit because of the political nature of fiscal policy. Credible fiscal rules and institutions need to be put in place to bring debt ratios back to reasonable levels, while contingent liabilities should be better accounted for in fiscal positions to provide a more accurate picture of fiscal risks.

Although the technical ability of monetary authorities to unwind the easing is not questioned, how to do it and when to do it will be challenging tasks mainly because of uncertainties related to the correct estimation of potential output and size of output gaps in a post-crisis environment.

It will be relatively easy to unwind financial interventions that have sunset clauses or have penal rates so they become unattractive as market conditions normalize. The challenge is how to offload risky assets in central bank balance sheets and how to unwind debt guarantees and blanket deposit insurance.

Role for the IMF

The International Monetary and Financial Committee (IMFC) has asked us to continue work on these issues, and we will soon have a discussion in the Fund’s Executive Board on good principles for exit.

2 Responses

“Further, economic and financial indicators should guide the exit strategy. These indicators should include quantity, as well as price signals—in particular, developments in the aggregate and sectoral credit variables.”

Do you have any more colour on exactly what indicators were discussed?

Great article. Now I understand why the market is so concerned about the great unwind…it sounds impossible and large missteps seem almost inevitable.

The IMF responds:
No single statistic or indicator can provide conclusive evidence on the effectiveness of the crisis-related interventions and the case for exit. A set of indicators could, however, offer valuable guidance on the existence of preconditions and on how various exit measures are working in. Some of the macroeconomic indicators could include GDP growth and inflation, unemployment as well as capacity utilization rates. On the financial side, some examples are Libor-OIS (Overnight Indexed Swaps) spreads and corporate or sovereign CDS spreads. Relevant signals for exit could also be generated by quantity indicators such as loans to the private sector, to corporations and to households. But, again, I would like to stress that it is the full spectrum of metrics rather than a specific indicator to provide policymakers with useful information in this difficult exercise. You may see some discussion on this in the IMF paper, “Crisis-Related Measures in the Financial System and Sovereign Balance Sheet Risks,” issued on September 15, 2009 and the GFSR Chapter 3.